USP

USP stands for unique selling proposition. A USP is what distinguishes a product or project from all others in the marketplace. To succeed, differentiation is required. As an example, let's look at the USP of the first two popular electric cars. The Tesla S differentiated itself by being the first luxury electric car. The Toyota Prius, on the other hand, was the first affordable electric car of quality. Both differentiated from the marketplace by being electric, and they differentiated from each other based on price. Back to blockchain, just about everyone conflates crypto assets with cryptocurrency, but we find them to be distinct. Cryptocurrencies are tokens that are related to blockchains that are intended to be money. Crypto assets are tokens that relate to blockchains that are not intended to be money, for example, a smart contract platform.

Bitcoin is a blockchain that is being used as money, as an exchange of value, and that's pretty much it (it is a money use case). At this point, it is one of hundreds or maybe even thousands of crypto assets that don't do anything but act as an exchange of value. From our purview, Bitcoin solved the money use case. However, let's look at some of the copies. Litecoin is perhaps the most famous. It is a fork (copy) of the Bitcoin blockchain, and it modified some of the ways the Bitcoin blockchain worked and, yes, it has a faster confirmation time, but we don't see this as being sufficient differentiation. At the end of the day, it doesn't do anything that Bitcoin doesn't do.

Neither does Bitcoin Cash, BitcoinSV, Dash, Digibyte, Dogecoin, and so on. Sure, people have still made money on these coins, but we must consider whether they provide something new and different. If an offering lacks differentiation, it won't succeed. Will they stand the test of time? Some tout better speed or privacy, which might be important, but is it enough to make that coin stand out uniquely? In the case of apples‐to‐apples comparisons, on the surface, there isn't much of a USP for any of these.

Case in point, if I open up a coffee shop next to Starbucks and I serve essentially the same product but have a different logo – maybe an orange whale instead of a green mermaid – what will incentivize people to buy my coffee? Sure, some will because it's not Starbucks but, in general, Starbucks has solved the quality, consistent coffee problem and established such a marketplace that without differentiation, it's hard for new coffee shops to compete. Some now focus on pour‐overs, have a more casual environment, better pricing, or specify the essence of their roasting of beans. Some are much higher end. These shops may succeed, but copycats that produce a similar product with similar quality and price simply won't compete.

With regard to nonmonetary assets, let's revisit smart contracts. Smart contract platforms include projects like Ethereum, Solana, Cardano, Algorand, and many others. The overall goal of a smart contract platform is to allow the building of blockchain applications. They are toolkits to launch other blockchain projects, which include, but are not limited to, NFTs, DeFi protocols, Metaverse platforms, and, in general, other blockchains. Ethereum was the first to popularize the concept of smart contracts, and that was their USP. Ethereum also became notorious for being expensive and not very scalable. While the Ethereum Foundation is admirably working to resolve these problems (and may indeed have done so by the time you read this), they opened up the door for other players to compete. Solana, a competitor, ostensibly does the same thing as Ethereum but proposed a new type of consensus mechanism. Where Ethereum initially used proof of work, then migrated to proof of stake, Solana considered the idea of a proof of history mechanism. Proof of history uses blockchain timestamps to determine consensus much faster and at a lower cost. Solana brought a unique selling proposition to the table. Tron, on the other hand, basically copied Ethereum and (upon launch) didn't bring anything unique to the table. We argue that  Tron has no distinguishable USP of significant value.

Moat

We all know of medieval times when kings and queens would reside in towering castles to rule their kingdoms. These images of lavish stone fortresses almost always are envisioned with a drawbridge that allows people to cross over a body of water – a moat – that surrounded the castle. The purpose of a moat is quite simple: to make the castle difficult to attack. The arduous task of swimming through a body of water to get the right to scale a stone wall while castle guards shoot arrows down at you is enough to scare most attackers off. Those who did attempt to overrun the compound found that the cost of life was significant and that traversing a moat is not that easy.

That's pretty dramatic; however, the principle of a moat as a characteristic of a project remains the same. If a project can be easily attacked, it becomes more vulnerable, so we want to consider projects that are defensible and have a moat. In 2009 it could be argued that Bitcoin did not have much of a moat. Anyone could copy the chain and attempt to build a better Bitcoin; in fact, many did. Fast‐forward, however, and Bitcoin now has a sizable moat, given by a 13‐year history, a $1 trillion market cap at its peak (as of this writing), the largest mining community in the world, and growing acceptance as money. Now, the moat is formidable. Its nearest competitor, Litecoin, had, at its peak, a $21 billion market cap, and very little acceptance during the same periods. Where Bitcoin has had continued strong support from the technical community Litecoin has languished. Even the founder of Litecoin, Charlie Lee, sold all of his Litecoin in 2017 – not exactly a vote of confidence. With that, by the way, many coins are competing with Litecoin for the position of being the “second” blockchain money, but we have to note here that we believe stablecoins (crypto assets pegged to another asset, such as a U.S. dollar) will ultimately solve the problem of exchange of value, while Bitcoin will most likely become a store of value for the digital world. With these in place, we just don't see that there's much of a chance of a secondary coin being viable over the long term.

If we look at smart contract platforms, the moat here seems primarily to be the technology. Everyone is trying to build a better (scalable, faster, less expensive) smart contract platform. Some, such as Solana, brought proprietary technology to the table, which became a part of their moat, because this technology is more difficult to copy and maintain. In this case, we see that specific technologies can be a moat themselves. In any case, when considering assets, be sure that they are defensible – if they are easily replicated or attacked, that becomes a problem.

Team

With any new blockchain, new token, or any project of any kind, really, consider that the team is everything. As such, we encourage you to take the time to understand who the team is. Have they successfully executed technology projects before? Do they have significant backing from known venture firms? Do they have credible advisors with a proven history of success?

While the mysterious Satoshi Nakamoto remains anonymous, the code that runs the Bitcoin blockchain has been reviewed, vetted, and is publicly visible and available. This code, known as the Bitcoin core, is maintained by a group of developers, the lead of which is currently Wladimir Van Der Laan, who has been involved since 2011 and who took over the lead role from original core lead Gavin Andressen in 2014. In addition to Van Der Lan, many other core developers maintain the project, and, as there is no “company” behind Bitcoin, these developers are subsidized by grants by well‐known institutions. For example, Van Der Laan's work is funded by MIT Media Lab's Digital Currency Initiative (MIT DCI). Other noted developers have been funded by Square, Blockstream, Gemini, Coinbase, and other major players. In this case, we have a team led by someone with a proven track record of delivering on the code, supported by one of the greatest academic institutions in the world, MIT. Similarly, Polkadot was founded and is anchored by Gavin Wood, a research scientist at Microsoft before becoming one of the founders of the Ethereum blockchain. When considering Polkadot as a project, the fact that it had a lead with a proven track record goes a long way.

Regarding the counterexample, rather than throw anyone under the bus, we'll say that there are many blockchains and many tokens that have been created with teams that are not identifiable, have no history of technological success, or, even worse, have checkered pasts. Know your team.

Market Capitalization

Market capitalization, the overall public value of a blockchain, offers another important metric. This doesn't necessarily demonstrate who the users of a given project are. However, it does show how the market views a blockchain. Market capitalization is calculated by multiplying the number of tokens in circulation by the price of each token. Ultimately, projects that gain acceptance or at least are viewed to have potential will have a higher value per token and, as such, a higher market capitalization. There is an obvious question: If the number of tokens in circulation values a blockchain, why doesn't every project just circulate hundreds of billions of tokens? The short answer is, as we learned from the conversation about scarcity, more of something does not necessarily make it worth more. In fact, too much of anything will almost always depress prices, so this is a self‐correcting system in many ways. Projects that provide value and therefore demand that also have tokens of a proper supply will, by nature, have a higher market cap than projects that don't. Market capitalization measures this balance.

Market capitalization can be tricky, however, because there are many projects such as Dogecoin that, at one point, had a top‐10 market capitalization. While this may seem promising, this coin lacks every other key attribute listed here and, importantly, has not always maintained a strong market cap. We would then extend this concept to consider market capitalization over time. Ethereum, for example, has had the largest market capitalization of any Layer 1 smart contract platform since its inception. Other similar protocols have come and gone. Some have briefly danced alongside Ethereum and then have been abandoned. As a guideline, if a token has less than $500,000 in market capitalization, we would, in general, be very wary before adding it to our portfolio.

Acceptance

Acceptance in the world of crypto assets – particularly technologies – boils down to a simple test: Is anyone using the platform? For many years, in the case of Bitcoin, no one was, and this was one of the main concerns of detractors. Now, however, you can use bitcoin at Microsoft, Whole Foods, Starbucks, and many other retailers. There is also a new trend where homebuyers can spend bitcoin to buy real property. In addition, you can also use bitcoin to pay taxes in some states, such as Colorado.¹ Every day there is more acceptance. Conversely, although one can use bitcoin, other alternative cryptocurrencies are generally not accepted at these retailers. This is important.

On the platform front, one only has to look at Ethereum to see that it has been the platform of choice for building blockchain projects since its inception. It has acceptance. Developers have constructed DeFi apps, NFTs, metaverse projects, decentralized exchanges, and many other assets on this blockchain. Recently, however, we've seen other chains start to gain traction, so this will be an exciting space to watch. Many DeFi projects moved to Solana in consideration of Ethereum's scalability concerns, and others, like Algorand, have recently cemented deals with FIFA. When examining any project, look to see who is using it.

Scarcity

As noted earlier, scarcity is an essential characteristic of sound money, and things that are scarce tend to have more value over time than things that are not. Consider what has happened with the U.S. economy over the past years. During the pandemic, the U.S. government printed approximately 40% of all dollars in circulation in a matter of a few years. That's a staggering number, and it's no surprise that, with inflation taking hold, we see that the average dollar is worth less than it was a year ago. In fact, as of this writing, it's worth about 9% less as measured by the July 2022 Consumer Price Index. Mo' money mo' problems, indeed. You would think that we would have learned, as we see from economies such as Zimbabwe, which realized almost unimaginable inflation, primarily due to overprinting money (see Figure 19.2).

How does this apply to crypto assets? Well, let's take bitcoin as an example. Bitcoin, as we've discussed, has a supply limited to 21 million coins. Period. With 19.2 million in circulation currently, the only way you can get a bitcoin is if someone wants to sell one at the price you are offering. Over time bitcoin has had significant price gains, and we believe this will continue in the future. Ethereum also takes this concept seriously as, originally, an unlimited supply was available. Realizing that this would not promote value appreciation in 2021, a code change was agreed upon by the Ethereum community and implemented in what was known as the London hard fork. Among other things, this code change made Ethereum disinflationary, meaning that coins were being taken out of circulation every time a block was made.

Conversely, let's consider Dogecoin. There are currently approximately 10,000 new doge put into circulation every minute. We challenge you to name anything with a potential unlimited number of copies, with more and more copies entering the market every day, that ultimately increases in value. That's not how it works. Scarcity drives values in all things, and digital assets, whether money, NFTs, or any other asset, are no different.

Regulatory Risk

In Chapter 6 we discovered that regulators are trying to get their arms around digital assets. It's a whole new world for them, and the SEC and CFTC are duking it out for control. Rather than ban crypto, however, they are really looking to ensure that it's implemented safely. The main thing the government wants is to ensure that crypto assets, which are the tokens related to a blockchain, are not sold like securities. As a quick callback to our regulatory chapter, securities are assets sold with an expectation of a return, and they are heavily regulated.

Let's say you take a functioning crypto asset like a token, and say, “okay, it's like bitcoin.” Then you conclude it's a commodity, therefore you're good to go and you buy some of the token, expecting a return. We would argue that process matters, and it's hard to qualify one‐offs or solitary initial coin offerings as commodities. They're not part of a bigger pool of goods that are largely the same.  The whole point here is to understand when an asset has the potential to be categorized as a security because, if it does, then you run a risk of the project being challenged – which often means “death by regulation.”

Let's say a digital asset comes into existence via an initial coin offering (ICO), where the offering is tokens in exchange for money upfront before a working network or product exists and where the investor expects to make a return. You're buying a stake in a new thing. It's speculation, and anything that falls into this category is most likely going to be classified as a security and will have to follow securities laws. This is exactly what you don't want to do as an investor, because you run the risk of the SEC challenging any project that looks and smells like a security. We urge you to not get caught up in the hype. Look instead at fundamentals and understand your risk.

Risk is a shopworn concept in finance, and we best understand risk as a continuum. It's important to assess where you are with your project or crypto asset, as an entrepreneur or as an investor, on this continuum. We use seven factors to evaluate regulatory risk for any particular crypto asset:

1. Is it a coin or a token?
2. If it's a coin, is it mineable?
3. If it's a coin, is it decentralized?
4. Is it functioning in production?
5. Was there an ICO?
6. Was it offered in the United States in a public or private sale?
7. If it is public in the United States, was there a know‐your‐customer (KYC)/anti–money laundering (AML) measure performed?

We can evaluate answers to these questions and see where we land in the continuum of regulatory risk. The least risky crypto asset is a coin being used in a functioning decentralized blockchain network. A coin by definition facilitates the operation of its blockchain and network. If the coin is mineable, so much the better because it's got different economics than if people bought it in an ICO (or other means) because, in such a case, miners received coins for work. This notion came out when the SEC announced that bitcoin was not a security. This was huge.

Conversely, if it's an ICO that was offered privately with a pre‐mined and centralized token with no KYC/AML performed, there is a very good chance that the SEC could come calling. At the very least we recommend that you use these two endpoints in your continuum and evaluate everything else as they relate to these points.

In a 2018 hearing before the House Appropriations Committee, Congressman Chris Stewart asked SEC chairman Jay Clayton to clarify his view on how regulatory oversight of cryptocurrencies could be split between the SEC and CFTC. Clayton responded:

It's a complicated area. Because, as you said, there are different types of crypto assets. Let me try and divide them into two areas. A pure medium of exchange, the one that's most often cited, is bitcoin. As a replacement for currency, that has been determined by most people to not be a security.

Then there are tokens, which are used to finance projects. I've been on the record saying there are very few, there's none that I've seen, tokens that aren't securities. To the extent something is a security, we should regulate it as a security, and our securities regulations are disclosure‐based, and people should follow those and provide the information that we require.

We don't agree that all tokens are securities, but we do acknowledge that a great many sure look like them upon examination.  These are the ones to be wary of. Finally, if a coin is premined and centralized, it's the riskiest type of coin. There are good chances that it has a high regulatory risk of being classified as a security. If the project is decentralized, it will be much less risky because it can be argued it's not a common enterprise. Tokens, by definition, are created on existing blockchains. For tokens the first question is: Is its network functioning? If the token has a functioning network, protocol, utility, or product, then it's less risky and is not a security. This notion emerged when the SEC announced that Ethereum is not a security because it has the features of being an active operating and functioning business enterprise with products and protocols.

The next set of questions revolves around how the crypto asset came into existence. Was there an ICO (money paid to get tokens before it hit the public market)? If so, there's more risk. If it was airdropped or came into existence another way, there's less risk. If there was a public sale in the United States, it's riskier than a private sale. A public sale of a token that did not do a KYC/AML is riskier than one that did. If you have a token that did an ICO and it's not currently functioning and you did a public ICO in the United States with no AML/KYC, then you have the most regulatory risk and you will most likely have to deal with the SEC.

Ripple Labs is in the midst of this as, in December 2020, the SEC sued, claiming they had raised $1.3 billion by selling XRP through unregistered security transactions. Ripple Labs and the SEC are basically dueling it out right now, with the main question being “did they pass or fail the Howey Test?” This will probably be resolved by the time you read this and, if we had to predict, there will be some kind of a deal made. This is of course at the conclusion of a long and drawn‐out three‐year court case, during which the price of the token cratered as well as soared only to crater again. Importantly, no one knows how this will turn out, but, we argue, why take the risk? We specifically avoid investing in anything that remotely resembles a security. We recommend that you do the same.

In addition, we recommend that you stay abreast of regulations – we know that can be a lot and a daunting task, but this universe is evolving. Our hope is that we see slow but steady regulation like the Token Taxonomy Act (introduced in 2021 and still pending), which excludes digital tokens from the definition of a security under federal securities laws. As clarity such as this unfolds you will be able to make more sound investments but, until then, we always recommend a more measured approach. The last thing you want is for your amazing investment to be clamped down by Uncle Sam.